Next's stores struggle in H1 but online is up, Q3 and international sales improve

All eyes were on Next on Thursday as this bellwether firm for the UK retail sector turned in its interim results. And what did we get? As expected, more than just a touch of gloom but there was distinct hope for the future also added in to the mix.

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The retail giant said the first half of the financial year has been “difficult and sales and profits are in line with our cautious expectations.” But its performance in the last three months has been “encouraging on a number of fronts”. And while retail remains undeniably tough, “our prospects going forward appear somewhat less challenging than they did six months ago.”

And it’s backing this slight optimism by taking the opportunity to “modestly upgrade” its sales and profit guidance for the full year. They should now range from a fall of 2% to a rise of 1.5%.

This guidance hike is being helped by a focus on improving the product that it said started to yield results in Q2 and should be even more visible in the current Q3 and especially when winter ranges drop during October. The firm’s price increases having been less than expected (around 4% so far with 2% expected next spring and no increases for AW18) have also meant less of a negative impact than some had feared.

UPS AND DOWNS

Before we break out the champagne, let’s look at the numbers for the six months to July.

Next Brand full price sales in the first half were down 1.2% and total sales including markdowns were down 2.3% on last year to £1.861 billion. Total Next Group sales fell 2.2% to £1.914 billion and Next brand profitability overall was down 9.3% to £306.6 million. Group profit before tax was down a heftier 9.5% to £309.4 million and earnings per share (EPS) fell 6.2%.

Importantly, the first half saw a “marked divergence of performance between our Retail and Directory businesses, with sales and profits down in Retail but moving forward in Directory.”

While that’s bad news for physical stores, it is at least encouraging on the Directory front. Next had long enjoyed a first-mover advantage is its largely-online Directory business but that had slowed in recent periods as strong rivals emerged. If Directory is getting back on track, it’s certainly good news.

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Yet the stores are clearly facing a challenging time. Next Retail sales fell 8.3% to less than £1 billion (actually to £993.2 million) and that was with the 2.5% contribution of new space included. Meanwhile Directory rose 5.7% to £868.4 million and it looks like we may see a time soon when Directory sales outstrip those in its stores, even though stores still have an important part to play in try-before-you-buy support for online sales.

But more than sales, profitability is a big issue. While Directory profit rose 6.3% to £217.1 million, Retail profit plunged 33.1% to £89.5 million, further underlining online’s importance not just for sales but for keeping shareholders happy with fat profits.

Overall, the net operating margin on Next Retail sales fell from 12.4% a year ago to 9% this time as higher costs of imports, air freight, and more kicked-in. But interestingly, while there had been concerns that rises in the statutory minimum rates of pay in the UK would hurt the firm, it said that in-store productivity initiatives actually turned what would have been a 0.6% dent in the margin into a 0.2% gain. But the firm still expects the full-year net margin to fall from 14.7% to 11.8%.

Despite the bleak news on physical store trading, the company continues to expand its stores, remains committed to this channel and said it’s very profitable. It expects to increase net trading space by 85,000 sq ft this year. That’s less than it had planned a few months back with some openings slipping into next year and closure numbers increased from nine to 13. Additionally, 14,000 sq ft is being converted to concessions.

Importantly too, the company said that it’s taking slightly longer than expected for new and refitted space to be profitable. The main reason being that five stores haven’t met their targets after extensive revamps and the company said it over-estimated the profitability uplift it could get from cosmetic changes to stores.

NOW FOR THE GOOD NEWS

Moving back into the good news zone, Directory remains the company’s cash cow. The retailer is investing heavily in the Directory with personalisation, targeted marketing, an Amazon-style subscription service called NextUnlimited (offering benefits for £20 a year), major tech enhancements and more.

That makes sense given that the Directory division is buoyant with its total sales rise of 5.7% also including a full-price sales hike of a pleasing 7.4%. While full-price sales only grew 3.1% in Britain, abroad they surged 30.7%. And it seems its earlier decision to offer more than just Next brand products is the reason for its UK success.

UK Next branded sales fell 4.1% through the Directory, although a 7.4% drop in Q1 and a 1% drop in Q2 showed that the performance is starting to improve. Meanwhile UK Label sales were up 40.6% in the half with a 30.6% rise in Q1 and a 50.4% leap in Q2.

The company said Directory’s average active customers rose 4% to 4.9 million, driven by UK ‘cash’ customers (ie those not using its credit account), as well as international shoppers.

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All of this meant the Directory net operating margin edged up to 25% from 24.9% in the UK, although for the full year it should stay at 25%, which is lower than the year-ago 25.7%.

Overseas, as mentioned, the Directory is certainly proving successful and its profitability is gradually increasing. But while its first half sales rose almost 31%, much of that was to do with currency effects and they rose only 13% currency-neutral. They should be up 24% (10% currency-neutral) for the year so while exchange rates are adding a big boost, overall sales are still strong. Over the course of the year Next plans to increase the number of European countries served by its German hub and this should notably reduce costs and prepare it for any customs-related change slinked to Brexit.

NEXT LABEL

The results do show that the firm’s Label business, selling other brands than Next, is a real success story, both via third-darty brands and its owned Lipsy business. Both areas are doing “very well with sales being driven by a combination of additional brands and increased breadth of offer, better stock availability, better ranging, additional brochures and increasing customer awareness.”

Label and Lipsy operate with their partner brands in two different ways. With some partners, Next operates a wholesale model, buying their stock and selling it at its own risk. An increasing number of partners are now choosing to work with it on a commission basis and although net margins are lower here, Next is very much in favour of this approach as it sees higher sales growth long term from the model.

For the full year, it expects Label sales to rise 14% and the net margin to rise to 17% from 16% a year earlier.

Lipsy meanwhile saw sales up 21% to £49.6 million in the latest half as it rebalanced away from wholesale towards selling through Next stores and the Directory and the company is upbeat on its prospects.

So what are we to make of all this? Next is clearly not out of the woods yet but its Q2 performance and trading so far in Q3 are signs that a turnaround could be on the cards. The stores remain a challenge but Next is taking an omnichannel view and not seeing the sales it makes there in a physical stores bubble. While initiatives to boost Directory sales further appear to be paying off, the store chain still has its issues but it also has a future. The hope is that it will be one that can, at some point, include higher sales.

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